Debenhams dents Sports Direct profits but elevation strategy proceeds
Mike Ashley’s Sports Direct achieved what could at best be called a lacklustre year in the 12 months to April 29, although given the devastation seen in UK retail, perhaps we shouldn't judge it too harshly as its revenue and its profits – at least based on one key metric – did manage to rise.
And given that the company is in the middle of a big transformation, there's a lot going on at Sports Direct that means a single year’s performance isn't necessarily the best way to assess it.
The company said that group revenue increased by 3.5% but excluding acquisitions, disposals, a 53rd week and on a currency-neutral basis, revenue increased by only 0.7%.
You can see what we mean by lacklustre. That's quite a big list of factors to take into account to achieve only a 0.7% increase.
But, as mentioned, there’s much more going on than meets the eye so we really need to dig deeper into the figures and the firm’s explanation of them to see the full picture.
That 3.5% revenue increase added up to £3.359 billion and meant a 2% drop in UK Sports Retail revenue to £2.181 billion (with European Sports Retail revenue down 0.1%), a 594.6% rise in Rest of World revenue to £192.4 million, and a 22.7% fall in Wholesale & Licensing revenue to £186.3 million. Premium Lifestyle revenue rose 42.7% to reach £162.1 million so the more fashion focused unit that includes Flannels was buoyant.
The news gets more confusing from there. The group gross margin was down 130bps while reported pre-tax profits plunged 72.5% to £77.5 million. But underlying pre-tax profit rose 34.5% to £152.9 million and underlying profit after tax was up 57.7% to £104.9 million. Underlying Ebitda rose 12.2% to £306.1 million but the final figure, that is, reported profit after tax, fell 88.1% to £27.6 million.
What caused those big profits dips? The firm took a huge hit from an £85.4 million impact from its Debenhams investment and was also dented by one-off profit boosters that had happened in the prior year. And it saw a huge increase in net debt due to share buybacks and investments “as we execute our strategic priority to elevate our sports retail proposition.”
But CEO Mike Ashley was generally upbeat, highlighting the strong underlying figures, as was Michael Murray, the group’s ‘Head of Elevation’, who said: “The elevation strategy continues to exceed expectations. As the property pipeline and brand relationships accelerate, we are confident in achieving between a 5% and 15% improvement in underlying Ebitda for the coming financial period.”
In its overview of the financial year, the company called out the fact that results were at the top end of the expectation Ashley gave last year and that underlying pre-tax profit surged because of “maintaining a strong trading performance in the UK as we undergo the strategic shift to the elevated store and online offering, while starting to see the benefits of increased efficiencies in the UK and Europe.”
So clearly, the elevation strategy is what it's all about and the company is prepared to sacrifice profits in the short term in order to achieve its aims.
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What is that strategy? Sports Direct is opening upgraded new-gen stores and boosting its brand proposition, as well as connecting with the consumer much more via digital. It’s offering more choice and more premium product lines and continues to “strengthen" its relationships with leading third-party brands, including adidas, Nike, Puma and Under Armour.
But despite all the upbeat talk, we can't ignore the unimpressive retail stores performance and the weaker margin. The company said that the fall in the group gross margin was largely due to ‘acquisition accounting’ as a result of the US purchase of Bob's Stores and Eastern Mountain Sports, and increased inventory provisions “as all divisions invested in more significant product offerings.” All aspects of the business saw lower margins but operating costs actually decreased by 3.6% on efficiencies due to automation in the warehouse and rationalisation in Europe.
And those retail sales? We didn't really get an explanation for the UK Sports Retail decline, although perhaps we don't need one given that we know how tough the UK retail sector is at present. The unit accounts for almost 64% of total turnover.
European Sports Retail was affected by “changes in the store portfolio” and the boost to Rest of World retail came mainly from the US acquisition.
On the fashion front, the firm’s Premium Lifestyle chains, Flannels, Cruise and Van Mildert, saw a stronger performance, with sales surging mostly due to new Flannels stores and increased web sales. But the Premium Lifestyle gross margin for the year decreased by 190 basis points to 33.3% (FY17: 35.2%), “largely due to an increase in stock provisions and customer demand for the latest products.”
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